Friday, 18 July 2008

UK money supply continues to grow at double digit rates

Brace yourself for more inflation. The UK money supply is currently growing at 11.5 percent a year. In fact, the growth rate picked up in June, reversing the declining trend of the early months of the year.

So how can the money supply be growing when we are supposed to be in a the middle of a credit crunch? Well, bank balance sheets are still growing and banks are still lending.

M4 measures bank balance sheet activity, which is the largest and most important component of the money supply. The M4 measure itself looks at deposits, which are bank liabilities. We can also look at monetary growth from the "other side" of the balance sheet - assets.

M4 lending, excluding securitizations, is also powering ahead. Who are the banks lending to? Well, we know from today's gross mortgage data that the banks are keeping away from the housing market. Similarly, the interbank market is supposed to be dead.

Ominously, the MPC are now preparing the ground for a further surge in inflation. Sir John Grieve, the soon departing deputy governor, warned that inflation will go "well beyond 4 percent" this year. Grieve also said that the bank will "do what ever it takes" to get inflation below the 2 percent target; everything, that is, except raise rates.

Sir John and the rest of the MPC wobblers should remember a couple of very basic things. First, and most important, rapid monetary growth causes inflation. Second, and almost as important, it takes a little while before fast monetary growth feeds through into rapid prices. Third, rapid monetary growth does initially generate extra economic growth, however this effect is temporary. Once prices start to rise, this spurt of growth evaporates.

For the last couple of years, the MPC have allowed the money supply to grow far too quickly. During the early period of this policy of loose money, it generated asset price inflation, particularly in the housing market. As the housing market crashed, rapid monetary growth fed through into other markets. Now, we are seeing regular old fashioned goods inflation.

There is only one solution; tighten monetary policy; raise rates and do it now. The longer the MPC prattles on about "balancing risks" between growth and inflation, the higher the inflation rate will rise. The MPC should forget about targeting growth and focus on price stability. Let everyone else worry about increasing GDP.

Peter: fascinating Telegraph article... I'm particularly taken by these quotes:

The M4 money data - which includes a wide range of bank accounts as well as cash - often gives advance warning of major shifts in the economy.

Do we know which types of bank accounts these are - and can we get a breakdown of M4 by bank-account-type? I think this would shed considerable light on the matter of broad money.

Mr Congdon: "The money supply is plummeting."

Is it? It doesn't look as if it is to us. What are we missing? With the exception of all the published M4 expansion figures that I see, everything else suggests a contracting money supply. What are we misinterpreting?

M4 is banks pulling assets back onto balance sheet, which stretches capital, which leads to LESS lending not more. Right?

None of the basic money supply numbers work, which is why Volcker had so much trouble trying to use them. Mish has a good article from 2006 on it and has recently opined on using Austrian money supply instead.